Crude and its refined products, like any commodity, are ultimately priced on supply and demand. Sounds simple enough. The one complication added to these pricing inputs; expectation of future supply and demand. The sharp run up in crude prices the past few weeks shows how big a role expected supply and demand plays. The one buffer that will temper or exasperate expectations is spare production capacity.
No one really knows for sure how the problems in North Africa and Middle Eastern countries will resolve. We could experience a swift and peaceful change of these governments to stable democracies, continued prolonged unrest, or a combination of the two. What is known is the world is consuming 88 million bbls per day, up 2.7 million bbls per day from last year and expected to grow an additional 1.7 million bbls per day this year. At current crude production rates there are 4 to 5 millions bbls per day of spare capacity.
Even without turmoil in the Arab countries, the rising world demand for crude will cut into spare production margin bringing it down to 3 million bbls per day. Factor in potential production disruptions and the world could easily find itself with fuel supply shortages.
The narrowing of marginal crude production capacity is what is driving crude to multi year highs. Until more crude production capacity is added, or world economies collapse under the weight of higher crude prices, expectations will remain for supply not being able to outpace demand.
Saturday, February 26, 2011
Saturday, February 12, 2011
Will the Chicago Markets Follow the Deutsche Borse NYSE Lead?
The transformation of global capital markets ramped up quickly this week with the disclosure of Deutsche Borse in talks to acquire NYSE Euronext. Should the proposed merger be approved, the combined entity will dominate derivatives trading in Europe and America and has the potential of dominating stock trading. Germany will become the epicenter of global capital markets.
The driving forces behind the merger are economies of scale and market share. Trading system costs and regulatory expenses will be reduced in direct relation to scale of trading volume. The combined Deutsche Borse/NYSE will be an unassailable global market share growth monster dominating both continents. Costs will be reduced and pricing power will increase as competition evaporates.
How are the Chicago exchanges along with Nasdaq going to compete against this new dominant force? Joining forces and fighting to keep and expand market share appears to be the best solution.
The Chicago Mercantile Exchange already dominates US futures trading. Increased trading volume will have to come from growth in Europe. Nasdaq has an exchange in Sweden, but will find it very difficult to grow in Europe with a combined Deutsche Borse/NYSE.
The Chicago Board of Exchange, CBOE, is the largest US options mart, with several extremely valuable, exclusively traded large volume options. Because of its US options dominance, the CBOE is a very likely, though very expensive, take over target.
A combined Nasdaq, CME, CBOE, with perhaps an Asian exchange added, would make a formidable competitor to a united Deutsche Borse/ NYSE.
Deal makers will probably wait to see if the proposed Deutsch Borse/ NYSE merger becomes reality. If and when it does, additional exchange market merger announcements will be forth coming.
The driving forces behind the merger are economies of scale and market share. Trading system costs and regulatory expenses will be reduced in direct relation to scale of trading volume. The combined Deutsche Borse/NYSE will be an unassailable global market share growth monster dominating both continents. Costs will be reduced and pricing power will increase as competition evaporates.
How are the Chicago exchanges along with Nasdaq going to compete against this new dominant force? Joining forces and fighting to keep and expand market share appears to be the best solution.
The Chicago Mercantile Exchange already dominates US futures trading. Increased trading volume will have to come from growth in Europe. Nasdaq has an exchange in Sweden, but will find it very difficult to grow in Europe with a combined Deutsche Borse/NYSE.
The Chicago Board of Exchange, CBOE, is the largest US options mart, with several extremely valuable, exclusively traded large volume options. Because of its US options dominance, the CBOE is a very likely, though very expensive, take over target.
A combined Nasdaq, CME, CBOE, with perhaps an Asian exchange added, would make a formidable competitor to a united Deutsche Borse/ NYSE.
Deal makers will probably wait to see if the proposed Deutsch Borse/ NYSE merger becomes reality. If and when it does, additional exchange market merger announcements will be forth coming.
Saturday, January 22, 2011
10% Probability of $4.00 Retail Gas In 2011
During an economic recovery, future demand expectations trumps current supply data bidding up futures for crude and refined products. This is why the energy complex has been on a relentless upward trend for the past two years. Seasonal refinery output factors that normally temper price movements have had little effect this year. Why is this happening?
The simple answer is that speculators have gone all in on long positions, taking profits at resistance levels and then repositioning long trades at support levels. This has prevented any sustainable sell off. It has also positioned term structures to move from a well supplied backwardation market to a high demand contango market.
The EIA released gas supply data last week showing gas supplies have been steadily increasing. Despite the ample supply, they are giving a 10% probability that retail gas prices will hit $4.00 per gallon, with a 50% chance of gas prices hitting $3.50 per gallon in 2011.
One hope for consumers is that everyone is leaning heavily to one side of the ship. Should a major demand or several demand reducing events occur in 2011, there will be a lot of traders trying to exit through a small door at the same time. Such an event would be China overshooting on its attempts to dampen its inflation. Another listing of the ship event would be the failure of several Eurozone banks.
Since neither of these events are highly likely to occur, traders will not try to rock the boat and continue positioning for the likelihood of a continued bull market.
The simple answer is that speculators have gone all in on long positions, taking profits at resistance levels and then repositioning long trades at support levels. This has prevented any sustainable sell off. It has also positioned term structures to move from a well supplied backwardation market to a high demand contango market.
The EIA released gas supply data last week showing gas supplies have been steadily increasing. Despite the ample supply, they are giving a 10% probability that retail gas prices will hit $4.00 per gallon, with a 50% chance of gas prices hitting $3.50 per gallon in 2011.
One hope for consumers is that everyone is leaning heavily to one side of the ship. Should a major demand or several demand reducing events occur in 2011, there will be a lot of traders trying to exit through a small door at the same time. Such an event would be China overshooting on its attempts to dampen its inflation. Another listing of the ship event would be the failure of several Eurozone banks.
Since neither of these events are highly likely to occur, traders will not try to rock the boat and continue positioning for the likelihood of a continued bull market.
Saturday, January 8, 2011
Falling Bond Prices Effect on the Energy Complex
Ben Bernanke and the US Federal Reserve are in the process of buying up $600 billion in treasuries in hopes of keeping interest rates low to help stimulate the economy. Bonds, however, are misbehaving. Interest rates on the ten year note is approaching critical technical levels that if broken, will likely set the stage for a secular bear market in bonds. Mr. Market is in the process of breaking apart long held economic theories.
Theoretical economics can be completely mind blowing. Yet no matter how complex the theory, in the long run, it will always need to obey the very simple laws of supply and demand. The acid test of any economic theory is whether or not a hypothetical idea plays out in the market. Ben Bernanke is hoping that injecting $600 billion into the economy buying treasuries will force interest rates down. Yet interest rates are going in the opposite direction. Why? And will this have any effect on the energy market?
The simple answer to why interest rates are heading up instead of down is that money flows are moving out of bonds with fears of future inflation diluting value.
Bonds have been in a secular bull market for the past twenty years. Bond traders are now carefully monitoring two year resistance of 4% on the ten year. Should this level give way the next major line of resistance comes in at 5.5%. A breach of interest rates above 5.5% by either the ten year or thirty year bond will be a strong signal to most bond traders that the long run of the bond bull market is over and a new secular bear market has begun.
If the bond market turns secularly bearish, will this tame the relentless bull market in energy? Probably not much. Upward trending interest rates are not good for any economy. Higher borrowing costs will be past along to consumers. The ultimate result is rising prices; inflation.
Crude oil remains a scarce resource. Light crude oil even more so. Long term continuation of falling bond prices will eventually lead to another recession. This may not happen for several years. Until then, demand for crude and its refined products will continue unabated supporting prices, keeping the secular crude bull market in place for several years to come.
Theoretical economics can be completely mind blowing. Yet no matter how complex the theory, in the long run, it will always need to obey the very simple laws of supply and demand. The acid test of any economic theory is whether or not a hypothetical idea plays out in the market. Ben Bernanke is hoping that injecting $600 billion into the economy buying treasuries will force interest rates down. Yet interest rates are going in the opposite direction. Why? And will this have any effect on the energy market?
The simple answer to why interest rates are heading up instead of down is that money flows are moving out of bonds with fears of future inflation diluting value.
Bonds have been in a secular bull market for the past twenty years. Bond traders are now carefully monitoring two year resistance of 4% on the ten year. Should this level give way the next major line of resistance comes in at 5.5%. A breach of interest rates above 5.5% by either the ten year or thirty year bond will be a strong signal to most bond traders that the long run of the bond bull market is over and a new secular bear market has begun.
If the bond market turns secularly bearish, will this tame the relentless bull market in energy? Probably not much. Upward trending interest rates are not good for any economy. Higher borrowing costs will be past along to consumers. The ultimate result is rising prices; inflation.
Crude oil remains a scarce resource. Light crude oil even more so. Long term continuation of falling bond prices will eventually lead to another recession. This may not happen for several years. Until then, demand for crude and its refined products will continue unabated supporting prices, keeping the secular crude bull market in place for several years to come.
Saturday, January 1, 2011
Will Crude Gain Another 15.1% in 2011?
The year 2010 was a great year for the bulls in almost every market. Equities around the world were higher. Gold, crude, bonds, US dollar, copper, wheat, corn; all paid handsomely to market participants trading long. With the economic recovery continuing to gain momentum, should traders simply repeat 2010 winning strategies, or has the long only trade become too crowded for 2011?
For energy traders the key to future prices heavily rests on future demand. Since the US and China are the two largest energy consumers, an investor's energy demand forecast for these two countries, will largely dictate the proper trade.
China is imposing higher reserve requirement and higher interest costs for banks to slow down growth. The Chinese government will likely be successful slowing growth. Still, they will likely continue to see GDP growth at 8% or better in 2011.
One other important factor in China's crude consumption overlooked by many is China's desire to build greater emergency reserve capacity. I like to call this factor the Chinese put. When crude prices dipped down into the $70's handle last summer, crude tanker shipments into China increased. Why? China has become an astute energy trader. They were busy buying up all available crude at cheaper prices and placing the barrels into emergency storage. They will repeat this exercise on any major market downturn, effectively giving long traders a free stop loss put.
With all the talk about China, the United States is still the number one consumer of crude, gas and diesel. Should the US fall back into another recession this year, energy prices will be affected dramatically. Unlikely as this might be to happen, traders will need to keep monitoring events in Europe that would have the potential to derail the US recovery. The problems with several Euro member sovereign debt are real and they are serious. If the debt is not handled in a real and serious manner, banking collapses will cause worldwide economic pain.
With demand finally chipping away at supply, crude, gas and diesel futures term structures are moving decisively from a contango market to a backwardation market. It is almost never wise to be short any commodity that is in contango, as products are coming out of storage and being sold decreasing forward supply.
Crude bears reading this may be screaming that the falling euro and strengthening US dollar is being left out of my 2011 forecast. And the bears are likely to be correct in this currency trend continuing in 2011. The stronger US dollar will help to alleviate a quick rise in crude to $149. However, 2011 is likely to be a year that breaks past correlations, with equities, commodities and the US dollar all rising together. Remember, currencies are driven by interest rates. US interest rates are on the rise.
In 2011 we may see crude gain 10% to 15%. Should the market give up some ground, traders should take advantage and add to long positions knowing the Chinese put is in place.
Happy New Year everyone!
For energy traders the key to future prices heavily rests on future demand. Since the US and China are the two largest energy consumers, an investor's energy demand forecast for these two countries, will largely dictate the proper trade.
China is imposing higher reserve requirement and higher interest costs for banks to slow down growth. The Chinese government will likely be successful slowing growth. Still, they will likely continue to see GDP growth at 8% or better in 2011.
One other important factor in China's crude consumption overlooked by many is China's desire to build greater emergency reserve capacity. I like to call this factor the Chinese put. When crude prices dipped down into the $70's handle last summer, crude tanker shipments into China increased. Why? China has become an astute energy trader. They were busy buying up all available crude at cheaper prices and placing the barrels into emergency storage. They will repeat this exercise on any major market downturn, effectively giving long traders a free stop loss put.
With all the talk about China, the United States is still the number one consumer of crude, gas and diesel. Should the US fall back into another recession this year, energy prices will be affected dramatically. Unlikely as this might be to happen, traders will need to keep monitoring events in Europe that would have the potential to derail the US recovery. The problems with several Euro member sovereign debt are real and they are serious. If the debt is not handled in a real and serious manner, banking collapses will cause worldwide economic pain.
With demand finally chipping away at supply, crude, gas and diesel futures term structures are moving decisively from a contango market to a backwardation market. It is almost never wise to be short any commodity that is in contango, as products are coming out of storage and being sold decreasing forward supply.
Crude bears reading this may be screaming that the falling euro and strengthening US dollar is being left out of my 2011 forecast. And the bears are likely to be correct in this currency trend continuing in 2011. The stronger US dollar will help to alleviate a quick rise in crude to $149. However, 2011 is likely to be a year that breaks past correlations, with equities, commodities and the US dollar all rising together. Remember, currencies are driven by interest rates. US interest rates are on the rise.
In 2011 we may see crude gain 10% to 15%. Should the market give up some ground, traders should take advantage and add to long positions knowing the Chinese put is in place.
Happy New Year everyone!
Saturday, December 18, 2010
Mexico Hedging and Energy Option Selling
Last week the Mexican government announced it had spent $800 million dollars buying crude puts in the $63 to $65 range. When triple digit crude prices appear to be on the doorstep, why did they place this hedge? The simple answer is that they are protecting their fiscal budget.
This is the proper and good use of hedging. Not to make additional profit, but to ensure an already budgeted profit.
Energy traders with a conservative risk tolerance should take heed of this action and look for opportunities to be sellers of put options, as there will be plenty of market participants similar to the Mexican government looking to buy options.
Although we may continue to see more pull back in energy futures as December winds down, especially with refiners looking to sell inventories to avoid ad valor em taxes and traders locking in year end profits. The outlook for 2011 is for energy to be well supported on any pullbacks allowing put option sellers to enjoy a profitable premium income stream.
This is the proper and good use of hedging. Not to make additional profit, but to ensure an already budgeted profit.
Energy traders with a conservative risk tolerance should take heed of this action and look for opportunities to be sellers of put options, as there will be plenty of market participants similar to the Mexican government looking to buy options.
Although we may continue to see more pull back in energy futures as December winds down, especially with refiners looking to sell inventories to avoid ad valor em taxes and traders locking in year end profits. The outlook for 2011 is for energy to be well supported on any pullbacks allowing put option sellers to enjoy a profitable premium income stream.
Sunday, December 12, 2010
The IEA and 78.6% Fibonacci
For the past several weeks the news has all been energy positive with big houses and OPEC raising energy demand forecasts for 2011. The International Energy Association (IEA), however, casts a different light on their forecast. Traders will do well to take heed.
The IEA released a tempered outlook for energy demand in 2011. They are foreseeing slower growth in China leading to a lower demand. Crude prices are being pegged to a range of $75 to $85. A sharp contrast to OPEC's $85 to $95 range. And even larger contrast to Goldman Sach's 2011 average price of $105.
The hope of a US economic recovery along with the Fed pumping the US economy with liquidity through a $600 billion bond purchasing strategy, has given traders the green light to add to long positions, driving crude past $90.
This has allowed traders to retrace the ever important 78.6% retracement level. A technical pull back is likely off this closely watched Fibonacci number. However, ultimately traders will need to heed any interest rate hikes coming out of China that will slow their economy and ultimately energy demand.
The IEA released a tempered outlook for energy demand in 2011. They are foreseeing slower growth in China leading to a lower demand. Crude prices are being pegged to a range of $75 to $85. A sharp contrast to OPEC's $85 to $95 range. And even larger contrast to Goldman Sach's 2011 average price of $105.
The hope of a US economic recovery along with the Fed pumping the US economy with liquidity through a $600 billion bond purchasing strategy, has given traders the green light to add to long positions, driving crude past $90.
This has allowed traders to retrace the ever important 78.6% retracement level. A technical pull back is likely off this closely watched Fibonacci number. However, ultimately traders will need to heed any interest rate hikes coming out of China that will slow their economy and ultimately energy demand.
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